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Chalk up another win for the financial sector Bullish Percent Index (BPFINA).
We turned bullish on the bank stocks last month when the BPFINA generated a “buy” signal. Given its track record, we figured the BPFINA would lead to a profitable trade.
Since then, the Financial Select Sector Fund (XLF) has gained 12%. It closed Wednesday at a new all-time high. And, it secured another profitable trade for the BPFINA.
Now, though, the conditions that had us leaning bullish on financial stocks last month have reversed. The BPFINA is in “extremely overbought” territory. It will generate a “sell” signal when it turns lower from here. And, that could happen as soon as today.
Take a look at this updated chart of the BPFINA…
As a reminder, a bullish percent index (BPI) shows the percentage of stocks in a sector that are trading in bullish technical patterns.
It’s an easy way to measure overbought and oversold conditions for a sector. Typically, a reading above 80 – meaning 80% of the stocks are trading in bullish technical patterns – means a sector is overbought. Readings below 30 indicate oversold conditions.
Buy and sell signals occur when a BPI reaches extreme levels and then reverses.
For example, when a BPI rallies above 80 and then turns lower, it generates a sell signal. When a BPI dips below 30 and then turns higher, that’s usually time to buy. At least, those are the general rules.
The red arrows on the chart point to the most recent BPFINA sell signals. All of those signals warned of impending declines in the bank stocks. And, all of those signals proved correct with the KBW Bank Index (BKX) declining 15% in two months following the sell signal in January. BKX fell 4% in one month after the April sell signal.
And, the sell signal in July preceded an 11% drop in the index.
The setup today looks most similar to the conditions we saw in April. So, I’m not anticipating a dramatic decline in the banking sector – just a modest correction of the recent rally phase.
Traders chasing the bank stocks higher into the current overbought conditions are likely making a mistake. We should have a better buying opportunity in a few weeks.
For now, folks who bought into the financial sector based on our suggestion last month should consider taking profits today.
Best regards and good trading,
Jeff Clark
Editor, Market Minute